Metis AM
As the UK’s central bank, the Bank of England (BoE) has many important responsibilities. One of these is controlling monetary policy, which influences the level of inflation.
In recent months, the price of many goods and services have increased sharply. According to data from the Office for National Statistics (ONS), the Consumer Price Index rose by 5.5% in the year to January 2022.
Due to this, the BoE have announced that they will be reversing a key part of their monetary policy that has been in place since 2008. Read on to find out what this will involve and how it could affect your wealth.
For several years, the Bank of England has used quantitative easing to support the economy
In February 2022, the BoE announced that not only did they plan to raise the base rate from 0.25% to 0.5%, they would also be ending their policy of “quantitative easing”. While it’s easy to be put off by this jargon, it isn’t as complicated as it sounds.
This policy involves the Bank buying large amounts of government bonds, known as “gilts”, to inject more liquidity into the economy. This also has the added bonus of keeping interest rates low.
Essentially, this is because purchasing a large amount of gilts pushes their price up, and so the bond yield goes down. This feeds through to lower interest rates from private lenders on loans for households and businesses, which encourages borrowing and stimulates the economy.
The Bank first introduced this policy in the aftermath of the 2008 global financial crisis but accelerated it in 2020 to help the government pay for its pandemic response.
By reversing their monetary policy, the Bank hopes to reduce the rate of inflation
While this policy may be useful for supporting an unsteady economy, it can have one unintended side-effect. Due to the large influx of money, quantitative easing can cause the prices of goods and services to rise.
Now, with inflation at a 30-year-high, the BoE is hoping to lower it by reversing their monetary policy. This is called “quantitative tightening”.
In their February report, the BoE announced that they would stop buying gilts until at least 2023 and plan to sell a large portion of the corporate bonds they own.
In theory, this should have the opposite effect to the Bank’s previous policy. By refusing to buy more gilts, this forces the government to raise their yield to make them more attractive to investors.
In turn, this should encourage lenders to raise interest rates, which will reduce the amount of borrowing and spending, cooling the economy and lowering the rate of inflation.
The policy change could negatively affect investors and prospective homeowners
In recent years, quantitative easing has significantly boosted the value of many assets, such as property and equities. However, if the BoE commits to reversing this policy, it could have a significant impact on the economy.
For a start, it could lower the value of some of the assets in your portfolio. Since gilts are typically considered a low-risk investment, if the government raises the interest rates for them, it may make many corporate bonds less attractive.
Since higher rates tend to negatively affect earnings, this could mean that any equities you hold in your portfolio may not grow as fast as you hoped.
Furthermore, the change could also make it more expensive to buy houses, making it more difficult for buy-to-let landlords and young people trying to get onto the property ladder.
The reason being that if gilts offer higher yields, banks can earn large profits simply by buying these safe investments. As a result, they may be less willing to lend money to prospective homeowners, as doing so is much riskier.
This would mean that if you wanted to secure a mortgage, you may have to put down a larger deposit, to show that you are less of a risk to the bank. Furthermore, due to potentially higher interest rates, your monthly repayments may also be more expensive.
If you’re concerned about how this change in policy could affect your progress towards your financial goals, you may benefit from seeking professional advice. Working with a planner can help you to make informed decisions when growing your wealth, enabling you to do so in a more effective way.
Get in touch
If you want to know more about what quantitative tightening might mean for you, get in touch. Please email enquiries@metiswealth.co.uk or call 0345 450 5670.
Please note:
This article is for information only. Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
